Fed Drops Tightening Bias, but No Easing Signaled

As expected, the Fed held rates steady in January, but importantly downplayed the likelihood that rate cuts will start as soon as March.

No change in rates at today's Federal Open Market Committee (FOMC) meeting, which was expected. It was a unanimous decision and represented the fourth consecutive meeting during which the Fed remained in pause mode. That keeps the fed funds rate in a range between 5.25% and 5.5%, with the most recent rate hike having been back in July 2023. In the FOMC statement, the Fed excluded its prior assertion that another rate hike was possible; instead suggesting a more balanced assessment of the policy path looking ahead.

"The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance," the statement read. Per the policy outlook, the Fed was noncommittal: "In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks." Dropped from the December FOMC statement was the tightening bias: "In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments."

However, there was no expressed rush to move to easier policy. Instead, the statement noted that the "Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%" (emphasis mine). Within the statement, there was an adjustment of the assessment of the economy, now describing activity as "expanding at a solid pace."

Regarding the health of the financial system, the statement omitted a sentence from the December FOMC meeting about the "U.S. banking system [being] sound and resilient," and that "tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation." Instead, today's statement noted that the "economic outlook is uncertain, and the Committee remains highly attentive to inflation risks."

With regard to the Fed's balance sheet, the statement reiterated the current pace of reduction totaling as much as $95 billion per month via the combination of Treasuries and mortgage-backed securities. The Committee also reaffirmed its long-term monetary policy strategy, including the commitment to a 2% (average) inflation target.

In the immediate aftermath of the release of the FOMC statement, the probability of a March rate cut dropped from more than 70% at one point today to 45% immediately after the announcement and then settled around 47% as of this writing (per the CME FedWatch Tool). Stocks sold off initially, rebounded, and then sold off further as Powell pushed back on cutting rates soon. Bond yields rose off their lows of the day.